Opinion: How Cheaper Oil Could Help, Hurt Aviation

The most fundamental change in the aviation industry in recent years is the rise in the price of fuel. A decade ago, the world's airlines spent $44 billion on jet fuel, accounting for 14% of operating costs. Today, the collective fuel tab is $211 billion, a whopping 31% of operating costs. Most industry executives assume that oil prices will remain at or around $100 per barrel for years to come—a driving force behind the record backlog for new, fuel-efficient aircraft.

Yet there is mounting evidence that consistently high oil prices may not be a certainty after all. Consider the following:

•Oil demand in the 34 developed OECD (Organization for Economic Cooperation and Development) countries is declining and, at 44 million barrels per day, is 10% lower than in 2005.

•New energy-efficiency standards in everything from buildings to new car models and continued growth in renewable energy sources promise to ameliorate oil demand.

•New oil-production technologies including horizontal drilling and hydraulic fracturing could add 3 million barrels a day of supply in the U.S., and are just now being deployed in other countries.

•Current geopolitical trends, from a potential U.S. rapprochement with Iran to a significant change in the Mexican constitution allowing foreign investment in the energy sector, will likely boost global oil supply.

The Economist magazine recently cited the possibility that demand for oil could peak in the not-too-distant future. What a change from the peak oil supply fears of several years ago. Whether or not this outcome is rosy-eyed optimism, it behooves industry executives and stakeholders to at least consider a lower-fuel cost environment as a plausible scenario for capital allocation planning. Financial markets are leaning this way, with the 2019 futures price of Brent Crude Oil at $85 a barrel. This begs the question: What would $85 oil mean for aviation?

The answer: Airlines could reap a bonanza. A 15-20% decline in fuel costs could mean about $35 billion in lower annual operating costs. This would have a major impact on airline profitability, particularly compared to today's paltry aggregate profit of just $12 billion. Airline shareholders would be major beneficiaries, as would passengers if ticket prices are reduced. This might also provide the means for wage adjustments for long-suffering airline employees.

Airfare reductions also could stimulate air travel demand, providing a much-needed kick-start to the stagnant North American and European markets while further bolstering emerging market demand. We could also see a new wave of airline start-ups. All of this would be good news for airports and aviation service suppliers.

The losers in this scenario would be aircraft manufacturers, which have built up record backlogs on a cocktail of high fuel prices, low cost of capital, and new technology. Lower oil prices mean new aircraft models promising 15-20% fuel consumption reduction are not as attractive from a financial perspective. Coupled with the current trend of increasing cost of capital, this could mean a wave of cancellations of sexy new aircraft models. Or it could mean manufacturers need to revisit pricing assumptions. What is a fair price for a new widebody like the Boeing777X, for example, in an $85/barrel world where its annual fuel cost falls by $3-4 million?

An interesting twist in this scenario is renewed life for aircraft models that are slated for early retirement. This could slow the current “retirement tsunami” that is harming operator and lessor balance sheets, as well as reducing MRO activity and aftermarket revenues.

In the late 1960s, Royal Dutch Shell popularized the modern strategic planning function by presciently planning for a future with geopolitical unrest and sharply higher oil prices, which hit a few years later with the Organization of Petroleum Exporting Countries' oil embargo and 1973 oil shock. While the price of oil is by definition unpredictable, and the global economy is just one exogenous event away from another oil price spike, today's industry leaders and stakeholders would be wise to include a lower oil-price scenario in their strategic thinking.

Contributing columnist Kevin Michaels is a vice president in ICF SH&E's Ann Arbor, Mich., office, where he leads its Aerospace & MRO practice.